Propel Morning Briefing

Market rents will exacerbate the differences in hospitality sector

Deutsche Bank leisure analyst Geof Collyer has argued that the proposed introduction of market rent option would probably mean the end of all pubco investment in their estates.

He stated: “Our best guess would be that the Bill gets passed into law, but with a delayed introduction (maybe two to four years) to allow the concerned companies time to prepare and adjust for the new paradigm. So it looks more likely that the tie will go – apart from smaller brewers.”

“The pubcos will want to increase their optionality for taking pubs back in house for direct management or selling on for (higher) alternative use, so agreements will probably revert to three to five year tenancies where as now there is no right of renewal or Landlord & Tenant Act protection, or maybe ‘5yr+5yr’ short leases with a break half-way. Since 2007, Enterprise has invested capex of £442m in its pubs, and a further £260m in discretionary support plus higher discounts and lower rent. Because the pubcos will no longer being able to guarantee returns, it is probable that all investment could be stopped, potentially exacerbating the perceived differential between tenanted/leased pubs and managed/casual dining chains. The brewers will be the biggest winners, licking their lips at the potential for higher margins.”

“With no more long term contracts, we would imagine that banks would be unwilling to lend to licensees that have little cash flow visibility – taking the industry back to the Dark Ages of pre-Beer Orders days when no-one invested in tenancies and product choice was restricted.”

“We would be surprised if more than 20% of pubs took up the Market Rent Option so all share price reaction has been way over the top. But the market will want to look at the worst-case scenario. Yesterday we suggested 5% downgrades to FY’16E, net of mitigating actions by Enterprise, Punch and circa -2% for Marston’s. Commercial property groups trade around Net Asset Value versus >65% discounts for Enterprise and Punch. The market much prefers the guaranteed nature of fixed rent versus variable rent. Ironically therefore, increasing the proportion of profits from fixed rent could see pub property go up or the discount to NAV narrow sharply even though the valuations could be based on lower levels of profitability. Pub groups would start valuing their properties based on both rental income and investment potential, which is what would drive more asset sales (pub closures), and pubco REITs would become a reality. (Enterprise Inns alone has permission to convert). We will have to dust off our REIT model.”

 

 

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